Friday, October 29, 2010

Just the other day I again heard the claim that Social Security (in this context, the U.S. Social Security fund) was due to become bankrupt, and is expected to be extinct by 2030. I used to have this notion, too, until I came across this paper. It’s a paper by Dimitri Papadimitriou and L. Randall Wray, written in 1999. I ran across it in my previous research on Chartalism, and disabused me of any notion that Social Security, and for that matter, Medicare (or Social Insurance, as its Canadian counterpart is known) will ever be bankrupted out of existence. At least not until we first encounter either extreme inflation or deflation economy-wide.

The paper writes: “According to intermediate-cost assumptions, total income (of the fund) will begin to fall short of expenditures by 2020” and outlines several statistics for why this would be so, which is basically largely due to the retiring baby boomers.

The paper acknowledges that “the real burden will be faced by future workers who will have to produce the goods and services required by future retirees”. But the paper also states that “this issue is separate from the supposed financial crisis of the fund. The future problem will be one of distributive issues rather than financial”.

“Taxes paid by today’s workers are used to pay today’s retirees. If money is left over, it finances other government spending.” In other words, the fund surplus we see today merely enables government to incur more spending (After all, all the fund’s investments in government securities in effect funds government spending (and deficits).

“When the benefits due exceeds the proceeds from payroll taxes, the difference will be financed by raising taxes, borrowing, creating money or reducing government spending.” In other words, there will come a time when government spending will largely be made towards funding the pensions and healthcare of more retirees. What this also means is less spending on other items (defense, war, pork barrel projects). But the government will still have to undertake that spending, even if it means going into bigger deficits. After all, all that future government deficit will then be financed by the investments of the nation’s future workers who expect to be retirees themselves one day. For as long as somebody needs to set aside some savings, and is looking for an investment outlet, there will be a market for government securities.

In other words, when current taxes no longer match fund payouts, we can expect more government deficits to make up for the gap, in effect, perpetuating the fund. I know that in concept and practice, the fund seems like a Ponzi scheme (and it is), but then isn’t the whole business of older generations spending for the raising and caring of a new generation also one giant Ponzi scheme?

To finance fund deficits that would definitely come by 2020, the fund will also have to start selling assets. “Selling of assets will only work smoothly in funding the needs of retirees if those who obtained income from work in 2020 reduced their consumption in order to buy the assets being sold by the fund” (in effect replace the retirees on the savings side). “Otherwise, asset sales would merely depress asset prices, and the competition for consumption by workers and retirees would drive up the prices of goods and services.”

The authors write: “Future burdens (on the fund) can be reduced by increasing the growth of the labor force, by increasing employment opportunities, and by attracting new workers. ….In short, productivity gains plus labor force growth will together determine growth of real output.…..Unless we enhance society’s ability to produce goods and services by 2020, the amount to be distributed will be exactly the same whether the fund is larger, smaller”

The authors advocate a “pay as you go” system, and that taxes be reduced now so that fund revenues and costs are more easily aligned. The fund need not increase taxes now to accumulate more investments to prepare for the time in 2020 when program benefits are expected to surpass taxes. “Higher taxes (now) might reduce consumption (now), and might also depress (private) incentive to invest, generating unemployed resources, and further deteriorating consumption patterns.

“Simply trying to encourage investment by itself will not work in a demand constrained system because it just leads to excess capacity. It would be better to stimulate other spending that then creates the private incentive to invest …Government spending will raise demand and thus stimulate investment.”

In short, we have been doing everything possible to exacerbate the future situation of the fund. We advocate all sorts of austerity programs that destroy current demand, which destroys economic growth, and hence, diminishes the future economic pie that would be distributed for the time when there are more retirees on fixed income.

What we should be doing is focusing on improving productivity now, so that the economy produces enough goods to satisfy the needs of everyone by 2020 and onwards, whether they can still come to work, or can barely get out of bed. But a larger tax base now will depress consumption NOW.

A larger tax base will probably be necessary in the future if are to have a fund that can finance the needs of more retirees without relying too much just on deficits. (And in a future where the retirees are the majority, it doesn’t take much imagination whose interests future politicians will favour on most cases).

But a larger tax base when the time comes will be more palatable if there is enough income left over to satisfy the needs of those who'll be paying them by then, for their own consumption and savings. That income will only be sufficient if the economy is producing enough, so that nobody is priced out of basic necessities.

If productivity in basic necessities does not increase between now and 2020, then future competition for consumption will result in inflation down the line, and this will help no one. In that case, the fund being bankrupted out of existence will be the least of our worries. Extreme inflation (due to consumption competition) or deflation (due to excess saving without investment) will be.

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"Conventional approaches, unconventional conclusions" on the global finance and economic issues of the day. Rogue Econ has been a banker and financial consultant in several countries. Welcome to my blog.